Use the 529 'Grandparent Loophole' to Maximize College Savings
How the 529 grandparent loophole lets you fund a grandchild’s college education without impacting their financial aid.
A 529 plan is one of the smartest ways for grandparents to help save for their grandkids’ college education. Many grandparents contribute generously to these plans, often making large gifts or regular contributions, even though the accounts are owned by the parents. This allows grandparents to play an active, meaningful role in their grandkids’ future while preserving the tax and financial-aid advantages.
Due to changes to the Free Application for Federal Student Aid (FAFSA), the Asset Protection Allowance has dropped to $0, making more of a parent's assets potentially countable. However, 529 plan assets are still assessed at a maximum of just 5.64% of the account's value. Better yet, the FAFSA Simplification Act eliminated more than two-thirds of the FAFSA form's notoriously frustrating questions and officially closed a major financial aid hurdle: the "grandparent loophole." Now, distributions taken from grandparent-owned 529 accounts to cover a dependent grandchild’s qualified expenses are no longer counted as student income, allowing grandparents to fund an education without derailing aid eligibility.
Yet, few families take advantage of this powerful strategy. Data from a 2025 Edward Jones survey reveals that 52% of Americans are unfamiliar with 529 plans, and only 14% currently use or intend to use them.
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Missing out on these tax-advantaged accounts can hinder both college goals and long-term financial dreams. Bypassing 529 plans means families lose major benefits such as tax-free growth and the opportunity to roll unused educational funds directly into a Roth IRA.
What is the 529 grandparent loophole?
A 529 plan allows a contributor to prepay a beneficiary's qualified higher-education expenses at an eligible educational institution or to contribute to an account for paying those expenses. While 529 contributions must be made with after-tax money, the contributions grow free from federal or state tax.
How can the loophole benefit both you and your grandchildren?
Previously, distributions from a grandparent’s 529 plan were reported as untaxed student income, which could reduce a student's eligibility for aid by up to 50% of the distribution amount — a significant penalty. Under the old rules, a $10,000 529 plan distribution could reduce your grandchild’s aid eligibility by $5,000.
The good news is that with the new streamlined FAFSA (which took effect starting with the 2024-2025 award year), distributions from grandparent-owned 529 plans are no longer reported as student income, giving grandparents a welcome advantage.
What's different on the 2026-2027 FAFSA?
On the 2026-2027 FAFSA, students aren't required to report cash gifts from a grandparent or contributions from a grandparent-owned 529 savings plan. Grandparents can now use a 529 plan to fund a grandchild’s education without impacting that grandchild's financial aid eligibility.
With the new FAFSA form, a student’s total income is based on data from federal income tax returns. Cash support will not impact financial aid eligibility on the FAFSA.
However, more than 200 private institutions use the CSS Profile, rather than the FAFSA, to award financial aid. These plans take a more complete picture of your financial circumstances than the FAFSA does, and grandparent-held 529 plans will still be considered.
Gift tax thresholds
Additionally, 529 plans are subject to gift taxes when they exceed certain thresholds.
For 2026, the annual gift tax limits are $19,000 for singles or $38,000 for married couples filing jointly (unchanged from 2025). These limits apply to each person who is receiving a gift in a year.
This means that you can donate these amounts per grandchild each year without owing federal gift tax. However, your 529 contributions might trigger gift tax consequences. If you exceed the annual exclusion, you might need to file a gift tax return.
For example, if you have two students and two 529 plans, and you're a single parent, this year, you can contribute $19,000 each or $38,000 total in a year without reporting these contributions to the IRS.
However, any contributions above $19,000 each (or $38,000 each if you're married and filing jointly) must be reported to the IRS and will count toward your lifetime gift tax exemption of $15 million (up from $13.99 million last year) for individuals or $30 million (up from $27.98 million in 2025) for couples in 2026.
Give more than that limit, and you could incur a flat gift tax of 40% for the excess amount.
Tax-free rollovers to Roth IRAs
If you put money in a 529 plan for your grandchild and he or she didn't attend college or only spent a portion of what you saved, you can roll over funds from your 529 plan tax-free into a Roth IRA, as long as certain conditions are met.
Rolling over unused funds from a 529 account into a Roth IRA can help individuals avoid tax penalties that occur when withdrawing funds for non-education expenses.
There's a limit on how much money can be rolled over throughout the beneficiary's lifetime, and these rollovers are subject to Roth IRA annual contribution limits.
IRA contribution limits for the 2026 tax year are $7,500 for people under age 50 and an additional $1,100 catch-up contribution for those age 50 and older.
Before you get too excited, there are several additional limitations from the SECURE 2.0 Act worth keeping in mind:
- Your 529 savings account must be open for more than 15 years before funds can be rolled into a Roth IRA.
- If the 529 beneficiary is different from the 529 holder, the Roth IRA must be in the beneficiary’s name.
- 529 contributions made within the preceding five years cannot be rolled over.
- The beneficiary must have earned income for the year at least equal in amount to the Roth IRA contribution transferred from the 529 account.
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